Foreign currency risk
Foreign currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in foreign exchange rates. The foreign currency risk management distinguishes between three types of foreign currency risk:
foreign currency transaction risk, foreign currency translation risk and foreign currency economic risk.
The Group incurs foreign currency transaction risk on accounts receivable and accounts payable that are denominated in a currency other than the company’s functional currency. Foreign currency transaction risk in the Group’s operations also arises from the variability of cash flows in respect of forecasted transactions.
Foreign operations which do not have the Euro as their functional currency give rise to a translation risk. The foreign currency economic risk is the risk that future cash flows and earnings generated by foreign operations may vary. Foreign currency economic risk is highly connected with other factors such as the foreign operations’ competitive position within an industry, its relationship with customers and suppliers.
In monitoring the foreign currency risk exposures, the central treasury department focuses on the transaction and translation risk exposures whereas business management seeks to manage the foreign economic risk through natural hedges.
Each of the above types of foreign currency risk exposure impacts the financial statements differently.
The central treasury department monitors and manages foreign currency exposure from the view of its impact on either the statement of financial position or profit or loss.
Foreign currency transaction risk in the statement of financial position
The currencies that primarily impact the net foreign currency exposure on the statement of financial position are the US Dollar, Pound Sterling, Canadian Dollar and Australian Dollar.
With regard to these currencies, the Group was exposed as of December 31, 2011 to the following foreign currency risk:
NET EXPOSURE OF RECEIVABLES AND PAYABLES
HEDGING NET POSITION
CASH, CASH EQUIVALENTS LOANS & DEPOSITS
DERIVATIVE FINANCIAL INSTRUMENTS
MILLION FOREIGN CURRENCY
DECEMBER 31, 2011
USD 153.2 (134.6) 25.5 44.1
GBP 6.9 (16.4) 7.8 (1.7)
CAD (0.9) 1.6 - 0.7
AUD 19.9 (9.3) - 10.6
DECEMBER 31, 2010
USD 183.7 (194.6) 96.5 85.6
GBP 15 0.6 (15.8) (0.2)
CAD (18.6) (46.3) 52 (12.9)
AUD 14.4 (36.7) 27.9 5.6
The aim of Group’s management regarding transaction exposure in the statement of financial position is to minimize, over the short term, the revaluation results – both realized and unrealized – of items in the statement of financial position that are denominated in a currency other than the company’s functional currency.
In order to keep the exposures within predefined risk adjusted limits, the central treasury department economically hedges the net outstanding monetary items in the statement of financial position in foreign currency using derivative financial instruments such as forward exchange contracts. As of December 31, 2011, the outstanding derivative financial instruments are all forward exchange contracts with maturities of generally less than one year.
Where derivative financial instruments are used to economically hedge the foreign exchange exposure of recognized monetary assets or liabilities, no hedge accounting is applied. Changes in the fair value of these derivative financial instruments are recognized in profit or loss.
Foreign currency translation risk in the statement of financial position
When the functional currency of the entity that holds the investment is different from the functional currency of the related subsidiary, the currency fluctuations on the net investment directly affect the shareholders’ equity (‘Translation reserve’) unless any hedging mechanism exists.
All subsidiaries and associates have as functional currency the currency of the country in which they operate. The currencies giving rise to the Group’s translation risk in the statement of financial position are primarily US Dollar and Canadian Dollar.
NET INVESTMENT IN A FOREIGN ENTITY
MILLION FOREIGN CURRENCY DECEMBER 31, 2011 DECEMBER 31, 2010
USD 494 564
CAD 279 269
The central treasury department monitors the translation exposure in the statement of financial position of the Group at least on a quarterly basis. The Treasury Committee proposes corrective actions if needed to the Executive Management.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 93
During 2011, the USD denominated bank loans (120 million USD) hedging the foreign currency exposure of the Group’s net investment in its subsidiary in the United States (Agfa Corporation), have been rolled over into forward exchange contracts (120 million USD). As of December 31, 2011, the hedge of the net investment in Agfa Corporation (US) has been determined to be effective and as a result the effective portion of the gain on the hedging instruments has been recognized directly in equity (Translation reserve: 24 million Euro, before tax).
Foreign currency risk in profit or loss
Foreign currency risk in profit or loss includes both the risk of the variability of cash flows in respect of forecasted transactions as a result of changes in exchange rates and the risk that the profit (loss) for the year generated by foreign operations may vary in amount when translated into the presentation currency (Euro). The central treasury department monitors and manages both risks simultaneously.
The currencies that primarily impact the net foreign currency exposure in profit or loss are US Dollar, currencies highly correlated to the US Dollar – i.e. Hong Kong Dollar and Chinese Renminbi – Canadian Dollar, Pound Sterling and Australian Dollar.
The Executive Management decides on the hedging policy of aforementioned currency exposures considering the market situation and upon proposal of the Treasury Committee. The objective of the Group’s management of exposure in profit or loss is mainly to increase the predictability of results but also to protect the business within a defined time horizon in which the business cannot react to the changing environment (e.g. by adapting prices or shifting production).
In the course of 2010 and 2011, the Group designated foreign exchange contracts as ‘cash flow hedges’ of its foreign currency exposure in US Dollar and Pound Sterling related to highly probable forecasted revenue over the following 12 months. The portion of the gain on the forward exchange contracts that is determined to be an effective hedge is recognized directly in equity (December 31, 2011: nil; December 31, 2010: 1 million Euro). At the end of December 2011, all contracts reached maturity date. During 2011, gains amounting to 3 million Euro have been recognized in other comprehensive income. An amount of 4 million Euro gains has been reclassified from equity and included in revenue.
Sensitivity analysis
A strengthening / weakening of the Euro by 10% against the currencies listed hereafter with all other variables held constant, would have increased (decreased) profit or loss by the amounts shown below. The analysis has been carried out on the budgeted net exposure for the year 2011, net of the use of cash flow hedges.
PROFIT OR LOSS
2011 2010
STRENGTHENING OF THE EURO BY 10%
WEAKENING OF THE EURO BY 10%
STRENGTHENING OF THE EURO BY 10%
WEAKENING OF THE EURO BY 10%
MILLION EURO
USD AND CURRENCIES HIGHLY
RELATED TO THE USD - HKD - RMB 1.0 (1.0) (5.0) 5.0
CAD 1.3 (1.3) 0.9 (0.9)
GBP (4.0) 4.0 (6.8) 6.8
AUD (5.1) 5.1 (4.7) 4.7
Interest rate risk
Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in market interest rates. The Group’s exposure to changes in interest rates primarily relates to the Group’s net financial debt position, including the FX-swaps that economically hedge intercompany loans and deposits. For the most important currencies the following interest rate profile exists at the reporting date:
2011 2010
OUTSTANDING AMOUNT OUTSTANDING AMOUNT
MILLION EURO
AT FLOATING RATE AT FIXED RATE AT FLOATING RATE AT FIXED RATE
EUR (7) 265 (31) 195
USD 88 - 77
-GBP (11) - 18
-RMB - - 11
-CAD (33) - (39)
-AUD (21) - (21)
-JPY 9 - 15
-Sensitivity analysis
A change of 100 basis points in interest rates at December 31, 2011 would have increased (decreased) profit or loss and equity by the amounts shown below. This analysis assumes that all other variables, in particular foreign currency rates, remain constant. The analysis is performed on the same basis for 2010.
PROFIT OR LOSS
DECEMBER 31, 2011 100 BP INCREASE 100 BP DECREASE
NET IMPACT 0.1 (0.1)
DECEMBER 31, 2010
NET IMPACT 0.3 (0.3)
Commodity price risk
The Group’s most important raw material exposures relate to silver and aluminum. The Group’s commodity price risk – i.e. the risk that its future cash flows and earnings may vary because of changed material prices – is highly connected with other factors such as the Group’s competitive position within an industry, its relationship with customers and suppliers.
In order to prevent negative effects from potential future price rises or price volatility of silver and aluminum, the Group applies a strategy of partly purchasing at spot rates combined with a system of ‘Rolling layered forward buying’. This ‘Rolling layered forward buying’ is generally achieved by means of forward contracts that are entered into with commodity suppliers for the delivery of commodities in accordance with the Group’s expected usage requirements.
This ‘Rolling layered forward buying’ model has been set up mainly for increasing the predictability with respect to raw material prices. According to this model, the Group purchases a predefined % of the planned yearly consumption. The Commodities Steering Committee periodically reviews the commodity purchasing and hedging strategy. Deviations from the predefined ‘Rolling layered forward buying’ model are possible in which case the Corporate Executive Committee takes the final decision. The aforementioned model also considers the monitoring of the currency exposure related to the purchase of commodities.
The Group makes use of derivative instruments such as metal swap agreements that are concluded with investment banks, hedging the Group’s exposure to commodity price volatility related to highly probable forecasted purchases of commodities.
During 2011 and 2010, the Group concluded a number of metal swap agreements with an investment bank. These swap agreements have been designated as ‘cash flow hedges’, hedging the Group’s exposure to fluctuations in commodity prices related to highly probable forecasted purchases of commodities. It relates to commodity contracts that were entered into and
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 95
continue to be held for the purpose of the receipt of commodities in accordance with the Group’s expected usage requirements.
The portion of the gain or loss on the swap contracts that is determined to be an effective hedge is recognized directly in equity (December 31, 2011: (7) million Euro; December 31, 2010: 1 million Euro). During 2011, losses amounting to 10 million Euro have been recognized in other comprehensive income. An amount of 2 million Euro gains has been reclassified from equity and included in cost of sales.